BHI Policy Study

Beacon Hill Institute

April 2012

EXECUTIVE SUMMARY

Eliminating Property Taxes in North Dakota

David Tuerck, PhD Paul Bachman, MSIE Michael Head, MSEP
with

Brett Narloch
North Dakota Policy Council THE BEACON HILL INSTITUTE AT SUFFOLK UNIVERSITY 8 Ashburton Place Boston, MA 02108 Tel 617-573-8750, Fax 617-994-4279 E-mail: bhi@beaconhill.org, Web: www.beaconhill.org

Introduction Property tax revenue provides funding for some of the most visible services on which citizens are most dependent, including: public safety, education and recreation. For local governments, the property tax evolved as a dependable way to raise revenue. Since it is hard to evade, the property tax is easy to collect and thus a stable source of revenue barring events such as the current housing crisis, natural disaster and out-migration. In North Dakota, property taxes comprised 24.6% of state and local revenue in 2010.1 However, recent developments suggest that local government reliance on property taxes is problematic. The property tax remains one of the most unpopular taxes, in part, because it is a regressive tax. Property taxes bear no relationship to income or the ability to pay and, as a result, they can be a hard burden on the retired and elderly citizens on fixed incomes. In addition they burden those facing medical and economic setbacks. Moreover, a good part of the public believes that In response, property taxes, which rely heavily on assessments, are inherently unfair. 2

taxpayers since the late 1970s have placed constitutional or legislative limits on the ability of local municipalities to collect or increase property taxes. With North Dakotas commoditydriven economy booming, and the values of real estate escalating the debate over property taxes is now center stage.3 Fast growth can create supply shortages forcing property values to increase, generally faster than a homeowners earning power, especially those on a fixed income. Thus, property taxes can give government entities with property taxing authority a windfall at the expense of homeowners. Measure #2 will be on the June 12, 2012 election ballot to abolish property taxes in North Dakota, except for special assessments. If approved by the voters, the ballot measure would amend the state constitution and prohibit imposition of property taxes on all real property in the state. Without a doubt, this measure would greatly change the nature of public finance in North Dakota. State government would be constitutionally required to meet all the legal obligations of local government identifying state revenue sources and other state resources to fill the gap. At a time when many states in the nation suffer elevated unemployment rates and persistent budget deficits, North Dakotas position is exceptional. In December 2011, the unemployment

State of North Dakota Office of State Tax Commissioner, 2010 Property Tax Statistical Report, (June 2011):77; http://www.nd.gov/tax/property/pubs/stat-rep-10.pdf (accessed March 2012) and U.S. Census Bureau, State and Local Government Finances, http://www.census.gov/govs/estimate/ (accessed April 2012). 2 David Brunori, Local Tax Policy: A Federalist Perspective (Washington, DC: Urban Institute Press, 2003): 57-70. 3 Dale Wetzel, Tax commissioner candidate wants property tax study, Bismarck Tribune, May 25, 2010 http://www.bismarcktribune.com/news/article_c47b8546-6828-11df-b9fa-001cc4c002e0.html (accessed June 2010).

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rate fell to 3.1%, the lowest in the nation.4 The strong employment picture is one reason why North Dakota is in the rare position of maintaining a string of greatly expanding budget surpluses. The North Dakota Office of Management and Budget recently forecast budget surpluses of over $102 million for the fiscal 2011-13 Biennium.5 The pattern of tax revenues far exceeding budget forecasts has been in place for the better part of a decade. Figure 1 shows the amount that revenues exceeded the budget forecast for the last four Bienniums. In the 2005-07 Biennium and 2007-09 Biennium actual collections exceeded the forecast by over $350 million, or 18.3%, and $400 million, or by an astounding 20.3% respectfully. Over the past three Bienniums, actual revenues have exceeded budget forecasts by almost $300 million, with sales tax and income tax revenues exceeding the forecast on average by $100 million each. The trend continues in the current 2011 13 Biennium that is shaping up as a real gusher. Through March 2012, general fund revenues are $430 million or 31.4% more than the state forecasted in April, 2011. The Biennium still has 15 months of tax revenue collections left to tally. Figure 1: The Amount Actual Tax Revenues Exceeded Budget Forecast
500 450 400

350
Millions 300 Sales Tax 250 200 150 100 50 0 2003-2005 2005 - 2007 2007 - 2009 2009 - 2011 2011 - 2013

Personal Income Tax

Total (all taxes)

Figure 1 also breaks-out the amount of sales tax and income tax revenues that have exceed forecasts. Sales tax has exceeded forecasts by well over $100 million per Biennium and nearly
4

The U.S. Department of Labor, The Bureau of Labor Statistics, Local Area Unemployment Statistics, Internet, http://www.bls.gov/lau/ (accessed March 6, 2012). 5 The North Dakota Office of Management and Budget, Revised Revenue Forecast, February 14, 2012, http://www.nd.gov/omb/docs/revised-revenue-forecast-2-14-11.pdf (accessed March 2012).

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$250 million in the current Biennium. Personal incomes tax revenues have exceeded forecasts by almost $100 million during the past few budget cycles. Over the past three fiscal Bienniums, state tax revenues have increased by 18.6% (2005-2007), 17.2% (2007 - 09) and 19.4% (2009

11) to go from $1.953 billion in the 2003 05 Biennium to

over $3.242 billion in the 2009 - 11 Biennium.6 These budget surplus numbers would be significantly higher had the state legislature not increased budget expenditures at unprecedented rates. Had the state increased its spending between the 2001-03 and 2011-13 bienniums at the rate of increase in personal income the state surplus would be more than $1.7 billion higher. Had the state increased its spending during the same period at the rate of the CPI, state surpluses would be more than $4 billion higher.7 This illustrates a state spending trend that is unsustainable. Figure 2: The Amount Actual Tax Revenues Exceeded Budget Forecast
5500

4500

3500 Millions Total Tax Revenues Ending Fund Balances

2500

1500

500 2003-2005 2005 - 2007 2007 - 2009 2009 - 2011

-500

Over the same period the state of North Dakota has been adding to its surplus or fund balances. According to the North Dakota Comprehensive Annual Financial Report, the state ended Fiscal Year (FY) 2011 with over a $5 billion total ending balance in all funds. Total ending fund

The North Dakota Office of Management and Budget, North Dakota REV-ENEWS, June 2011, June 2009, June 2007, http://www.nd.gov/fiscal/budget/publications/revENews/ (accessed April 2012).
7

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balances have surged from $1.569 for Fiscal Year ending in 2005, which is 35% more than the $3.730 billion the state spent in all of FY 2011. 8 The state of Oregon has a unique method of dealing with excess tax revenues, the kicker amendment to the Article XV, section 14 of the state constitution forces the state to return to the taxpayers any tax revenue that exceeds estimated tax revenue by 2% or more.9 The state has issued checks to taxpayers in seven instances under the kicker law. According to U.S. Census Bureau data, the state finished FY 2009 with cash and security holdings, not including insurance trust funds that were 2.24 times its General revenue from own sources. This compares to an average across all 50 states of 1.06.10 State expenditures have risen by almost 70% over the same period, which is somewhat surprising.11 In times of such low unemployment and high economic growth the state should expect to spend less on government programs, especially for safety net programs. The states largess continues and is even showing signs of accelerating. The most recent

revenue tally from state Office and Management and Budget show that for the 2011-13 Biennium through March, 2012, state revenues have increased by over $600 million dollars, or an astounding 56.3% over the previous Biennium.12 The excess state tax revenue indicates that tax rates are higher than necessary to fund government expenditures and offers an opportunity for North Dakotans to address fundamental tax questions that, over the long-term, may benefit the economy. BHI developed and used its North Dakota State Tax Analysis Modeling Program (ND-STAMP) estimate the effects that this ballot measure would have on the state economy. 13 ND-STAMP is a five-year dynamic Computable General Equilibirum (CGE) model that simulates changes in taxes, costs (general and sector specific) and other economic inputs. As such, it provides a mathematical description of the economic relationships among producers, households, governments and the rest of the world. It is general in the sense that it takes all the important markets, such as the capital and labor markets, and flows into account. It is an equilibrium
8

The North Dakota Office of Management and Budget, North Dakota Comprehensive Annual Financial Report, 2011, http://www.nd.gov/fiscal/cafr/2011/ (accessed March 2012). 9 Oregon Constitution, Article XV, Section 14, Internet, http://www.leg.state.or.us/orcons/orcons.html (accessed April 2012). 10 U.S. Census Bureau, State and Local Government Finance, 2009 State and Local Government, State & Local Summary Tables by Level of Government, http://www.census.gov/govs/estimate/ (accessed March 2012). 11 The North Dakota Office of Management and Budget, North Dakota Comprehensive Annual Financial Report, 2005, http://www.nd.gov/fiscal/cafr/2011/ (accessed March 2012). 12 The North Dakota Office of Management and Budget, North Dakota REV-ENEWS, March 2012, http://www.nd.gov/fiscal/budget/publications/revENews/ (accessed April 2012). 13 For a description about the STAMP model see http://www.beaconhill.org/STAMP_Web_Brochure/STAMP_HowSTAMPworks.html.

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model because it assumes that demand equals supply in every market (goods and services, labor and capital). This equilibrium is achieved by allowing prices to adjust within the model. It is computable because it can be used to generate numeric solutions to concrete policy and tax changes. In the following section, we report the results as measured against a baseline economy with the current tax policies in place. Economic Effects Conceptually, the reduction in property taxes would provide a significant boost to the states private economy leading to an increase in private employment, disposable income and investment. BHI simulated the implementation of Ballot Measure #2 assuming that the state would need to reimburse local governments for the lost tax revenue. Table 1 displays the results that would occur above the baseline of what would occur without the elimination of property taxes or the percentage changes are relative to the projected baseline. 14 The ND-STAMP analysis shows that the elimination of North Dakota property taxes would increase private sector jobs by 13,171 in the first year by putting more money in the hands of households and businesses. The property tax elimination would also have a large effect on household income. Real disposable income in North Dakota would increase by $1.015 billion, or 4.12%, in the first year; and on a per capita basis it would increase by 3.7%, or $1,430 per person. Table 1: Annual Economic Effects of Ballot Measure #2
2013 2015 Employment (jobs) 13,170 13,990 Percentage Change 4.3 4.5 Investment, ($ million) 980 1,200 Percentage Change 35.3 35.8 Real Disposable Income ($ million) 1,015 1,100 Percentage Change 4.1 4.2 Disposable Income per Capita ($) 1,430 1,500 Percentage Change 3.7 3.8 Exports ($ million) 535 588 Percentage Change 1.9 2.1 The figures above represent changes to the economic variable relative to baseline projections without the tax policy change.

The elimination of the property tax leads to a reduction in the after-tax burden on income derived from capital investments. This provides a powerful incentive for business owners
14

We gather economic data from three sources: The U.S. Department of Labor, Bureau of Labor Statistics provides employment and wage data; the U.S. Department of Commerce provides income and investment data and the 2011 Comprehensive Annual Financial Report for the State of North Dakota provides supplements to the other sources.

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inside North Dakota to invest in their businesses because the return on the investment no longer has to take property taxes into account. Investment projects that may not have been profitable enough to justify the investment when taking into account property taxes, now become more profitable on an after tax basis. Moreover, firms looking to locate new facilities in the United States could find North Dakota an extremely attractive location in the absence of property taxes. To illustrate consider a firm such as Boeing which recently made significant location decisions around the U.S. Boeing would not need to negotiate individual tax breaks with state and local officials for special treatment the favorable conditions created by the abolition of the property tax would save tens of millions in economic development spending by the Department of Commerce and local development authorities, providing significant savings to both. Finally, the absence of the property taxes and subsequent individual tax breaks would place all firms seeking to expand their businesses in North Dakota on the same competitive playing field. It would end the favoritism that often accompanies development agencies selection of industries and firms that benefit from development policy. Table 2: Hypothetical Facility Investment in Cass County, ND v Clay County MN
Facility Investment Annual Tax Rate (%) Annual Tax Net Present Value of Total Tax Over 40 Years Total Investment plus Property Taxes MN $500,000,000 1.21 $6,032,997 $103,521,000 $603,521,000 ND $500,000,000 1.82 $9,076,385 $155,743,000 $655,743,000 ND (Ballot #2) $500,000,000 0 0 0 $500,000,000

Table 2 displays an example that compares the property tax burden of a firms hypothetical decision to invest $500 million in a new facility to be located in Cass County North Dakota or Clay Country Minnesota. Under current property tax laws, a firm would save over $5 million dollars in annual tax burden by locating the facility in Clay County Minnesota over Cass country North Dakota. Over the life of the facility, a firm would save $52 million in 2012 Net Present Value (NPV) dollars by building in Minnesota rather than North Dakota.15
15

Cass

State of North Dakota Office of State Tax Commissioner, 2010 Property Tax Statistical Report, (March 2012):77; http://www.nd.gov/tax/property/pubs/stat-rep-10.pdf (accessed March 2012) and U.S. Census Bureau, State and Local Government Finances, 75, http://www.census.gov/govs/estimate/ (accessed April 2012). Karen Baker and Nina Manzi, Minnesota House of Representatives, House Research Department Major State Aids and Taxes: A Comparative Analysis , http://www.house.leg.state.mn.us/hrd/pubs/msa2009.pdf, (access March 2012). We calculate the 1.82% by dividing the commercial property taxes collected $63.831 million by the taxable value of commercial property $175.816 million, which we have already divided by 10% and 50% to attain the full and fair value, or $3.516 billion. We use a discount rate of 5% to calculate the present value. We assume a steady full and fair value over the 30 year period.

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County, North Dakota would likely need to negotiate a tax incentive with a prospective investor in order to secure the facility. Abolishing the property tax would tilt the competitive advantage to Cass County, North Dakota as a firm would save $3 million per year and $103 million (2012 NPV dollars), or 25% of the cost over the lifetime of the investment without the need to enter negotiations with state and local officials for special tax breaks. The STAMP model simulation results confirm the above example. The absence of property taxes would cause investment to become more attractive in the state of North Dakota, with an increase in investment of $980 million in 2013 both from businesses located inside and outside North Dakota. However, over time, firms would approve more investment projects for North Dakota sending investment to surge by $1.2 billion in 2015. The state would boost its exports by $588 million by 2015 as North Dakota becomes an attractive location to source goods destined for the large Midwest markets of Chicago, Minneapolis, Kansas City, Milwaukee and even Denver. ND-STAMP allows us to calculate the dynamic revenue effects, as opposed to static effects, under the tax change. Table 3 displays the results.16 Table 3: Annual State and Local Tax Revenue Effects 2013 State Taxes Sales Tax Personal Income Tax Corporate Income Tax Other Revenue Subtotal Local Taxes Sales Tax Residential Property Tax Business Property Tax Other Revenue Subtotal Total 2015 $ millions 20 22 10 11 12 12 54 69 96 114 4 -432 -376 5 -799 -685

4 -409 -364 4 -765 -669

Static estimates assume that there is no change in underlying economic activity in response to a change in tax law. For example, a static estimate of a cut in the property tax, say 10% to 5%,

16

The 2010 Comprehensive Annual Financial Report for the State of North Dakota provides the data for state tax revenue collections and rates while the State and Local Taxes: an Overview and Comparative Guide 2009 from the State Tax Commissioner provides the local tax revenue data and also supplements the state report.

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would cause revenues to fall by 50% (=10 - 5)/10). A dynamic estimate would show a smaller drop in revenue because it would capture the positive effect on the tax base of the cut in the property tax. The complete elimination of property taxes in North Dakota would not enable any dynamic revenue effects for the property tax itself, since the rate would be zero. However, consumers and businesses would have more money to buy goods and services and make profitable investments in North Dakota, thus increasing retail sales and incomes, which, in turn, boosts income tax and sales tax collections. One of the principal purposes of STAMP is to capture such dynamic effects. Under Ballot Measure #2, we find significant dynamic revenue gains to personal income tax, corporate income tax and the sales tax. All three would increase by a combined $42 million in 2013 and $45 million in 2015. Other state tax revenues would increase by $54 million and $69 million in 2013 and 2015 respectfully. The state would realize ever-increasing tax gains over time. In total, the state would gain and additional $96 million in 2013, rising to $114 million in 2015. Local property taxes would fall by $773 million 2013 and $808 million in 2015. Local sales taxes and other revenue would increase by $4 million in each year. Combined state and local revenue would fall by $669 million in 2013 and $685 million in 2015. However, Ballot Measure #2 requires the state to compensate local governments for all of their lost property tax revenues for legally imposed obligations. In fact, local governments will gain $8 million to $9 million in revenue due to the increase in economic activity, such as an increase in the number of building permits. Prioritizing Spending With property taxes eliminated, the entire dynamics of funding state and local governments would become more taxpayer-friendly. State legislators would be faced with tougher budget decisions on how to allocate its abundant resources. After transferring funds to local governments, state officials would have to decide what combination of its current and projected budget surpluses, large current fund balances and spending would then be appropriated to balance the state budget. The North Dakota Policy Council's North Dakota Pork Report provides some examples of wasteful spending. In total, it identifies more than $460 million per year in wasteful spending.17 The report cites spending that would be unnecessary in the absence of the property tax, such as $54 million in economic development and other programs funded by the State Commerce Department. According to 2008 data from the US Bureau of Labor Statistics and calculations made by the NDPC, North Dakota had 1 state employee for every 19.35 non-

17

Brett Narloch, North Dakota Pork Report: 2007-09 Biennium, http://www.policynd.org/index.php?/site/PorkReport/ (accessed April 2, 2012).

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state workers. The national average is 1:29.03. If the state were to meet the national average there would be an annual savings, including benefits, of more than $300 million. 18 Local governments could also close or scale-back their economic development programs. The abolition of property taxes would effectively provide a substantial tax credit to all firms and projects in North Dakota without out the need to expend a single dollar in state revenue, thus negating the need to provide special funding to specific firms and projects. The North Dakota corporate income tax lists 20 credits to specific industries or sectors, such as the agricultural commodity processing facility investment credit.19 A firm owning an agricultural commodity processing facilities would no longer have to pay property taxes on these facilities, and would not need the special tax credit for this facility. Many of these credits could be eliminated under a property tax-free North Dakota. Another area of cost savings could be found in the property tax system itself. governments between $25 and $50 million per year.20 Conclusion The elimination of property taxes would lead to a more vibrant private sector economy. However, the elimination of property taxes will constitutionally require state government to replace the revenue for legally imposed obligations of local governments. These obligations must be funded prior to using state funds and resources for discretionary purposes. The state projects budget surpluses well into the future and had over $5 billion in total fund balances at the end of FY 2011. The ongoing surpluses indicate the tax rates are higher than necessary to fund government needs. The Oregon kicker law provides a unique mechanism for dealing with excess tax revenues by. The law forces the government to return excess tax revenue to the taxpayers by issuing checks or tax credits. In the absence of an Oregon type of mechanism, lower tax rates would eliminate the excess surpluses. The states surpluses enable it to absorb the new commitment without threatening other state government priorities and without the need to increase or add any new taxes. The absence of property taxes would provide an opportunity for state officials to review and eliminate spending and tax breaks intended to spur economic growth. Based on

discussions with tax officials in North Dakota, property tax administration cost local

Ibid Office of State Tax Commissioner, An Overview of Major State and Local Taxes in North Dakota, Internet, http://www.nd.gov/tax/genpubs/nd-tax-overview.pdf, January 2009 (accessed March 2012).
18 19

20

Based on telephone conversations with officials in Grand Forks, Fargo, West Fargo and Cass County.

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With its low unemployment, North Dakota is currently the envy of the nation. But the state cannot rest on its laurels. The opportunity for broad tax reform, if considered for its economic, and not political merits would be a huge benefit for residents for years to come. North Dakota can become an attractive location for businesses to site new capital projects. This would result in broadening of the states economic base thus making it significantly less prone to hardships during downturns in economic cycles. The positive benefits to the private sector of the state's economy brought about by eliminating property taxes are without question. Governments in North Dakota are well-funded; it may be time to give some of that money back to North Dakotas taxpayers.

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Methodology To identify the economic effects of the tax discounts and understand how they operate through a states economy, BHI utilized its STAMP (State Tax Analysis Modeling Program) model. STAMP is a five-year dynamic CGE (computable general equilibrium) model that has been programmed to simulate changes in taxes, costs (general and sector specific) and other economic inputs. As such, it provides a mathematical description of the economic relationships among producers, households, governments and the rest of the world. 21 A CGE tax model is a computerized method of accounting for the economic effects of tax policy changes. A CGE model is specified in terms of supply and demand for each economic variable included in the model, where the quantity supplied or demanded of each variable depends on the price of each variable. Tax policy changes are shown to affect economic activity through their effects on the prices of outputs and of the factors of production (principally, labor and capital) that enter into those outputs. A CGE model is in equilibrium, in the sense that supply is assumed to equal demand for the individual markets in the model. For this to be true, prices are allowed to adjust within the model (i.e., they are endogenous). For instance, if the demand for labor rises, while the supply remains unchanged, then the wage rate must rise to bring the labor market into equilibrium. A CGE model quantifies this effect. Finally, a CGE model is numerically specified (computable), which is to say it incorporates parameters that are believed to be descriptive of the actual relationships between quantities and prices. It produces estimates of changes in quantities (such as employment, the capital stock, gross state product and personal consumption expenditures) that result from changes in prices (such as the price of labor or the cost of capital) that result from changes in tax policy (such as the substitution of an income tax for a sales tax). Because it consists of a large number of interrelated equations, a CGE model ordinarily requires the application of a nonlinear computational algorithm, typically some variation on Newtons method. STAMP requires and utilizes the development and application of a sophisticated computer program for the solution of its equations.

For a clear introduction to CGE tax models, see John B. Shoven and John Whalley, Applied General-Equilibrium Models of Taxation and International Trade: An Introduction and Survey, Journal of Economic Literature 22 (September, 1984): 1008. Shoven and Whalley have also written a useful book on the practice of CGE modeling entitled Applying General Equilibrium (Cambridge: Cambridge University Press, 1992). See also Roberta Piermartini and Robert The Demystifying Modeling Methods for Trade Policy (Geneva, Switzerland: World Trade Organization, 2005) http://www.wto.org/english/res_e/booksp_e/discussion_papers10_e.pdf (accessed June 18, 2010).
21

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The Beacon Hill Institute Team

David G. Tuerck, PhD is Executive Director of the Beacon Hill Institute for Public Policy Research at Suffolk University where he also serves as Chairman and Professor of Economics. He holds a Ph.D. in economics from the University of Virginia and has written extensively on issues of taxation and public economics. Paul Bachman, MSIE is Director of Research at the Beacon Hill Institute for Public Policy Research at Suffolk University and a Senior Lecturer in Economics Suffolk University. He holds a Master of Science in International Economics from Suffolk University. Michael Head, MSEP is an Economist at the Beacon Hill Institute. He holds a Master of Science in Economic Policy from Suffolk University. Brett Narloch is the Executive Director of the North Dakota Policy Council. The authors would like to thank Frank Conte, Director of Communications at the Beacon Hill Institute, for editorial assistance.

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The Beacon Hill Institute at Suffolk University in Boston focuses on federal, state and local economic policies as they affect citizens and businesses. The institute conducts research and educational programs to provide timely, concise and readable analyses that help voters, policymakers and opinion leaders understand todays leading public policy issues.

April 2012 by the Beacon Hill Institute at Suffolk University

THE BEACON HILL INSTITUTE FOR PUBLIC POLICY RESEARCH Suffolk University
8 Ashburton Place Boston, MA 02108 Phone: 617-573-8750 Fax: 617-994-4279 bhi@beaconhill.org http://www.beaconhill.org

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